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PV E[ x i ]
1 ri where cov(x j , m)
ri rf ( M rf ) βi rf ( M rf ) σM ² Corporate Finance, Tri Vi Dang, Columbia University, Fall 2013 36 Implications
The equilibrium interest rate we can use to discount expected payoff depends on
the Beta of the project.
The higher is beta (i.e. the covariance between the project payoff and the payoff
of the market portfolio), the higher the interest rate.
In other words, if a project is positively correlated with the market, agents
require a higher interest rate. Corporate Finance, Tri Vi Dang, Columbia University, Fall 2013 37 Remark M rf : market risk premium (and it is positive empirically) The risk premium of asset i: i rf ( M rf ) β i
Implication i rf if β i 0 i rf if β i 0 i rf if β i 0 Corporate Finance, Tri Vi Dang, Columbia University, Fall 2013 38 CAPM and project choices
Suppose a firm has a project i with β i .
Suppose the expected return of the project is E[ri]. E[ri ] rf ( M rf ) β i , then do the project. If
Otherwise, do not do the project.
If you invest your money and buy an asset with the (same) β i , you get a higher
expected return. C...
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- Fall '14